Archive Press Releases

EMBARGOED UNTIL 10 A.M. EDT
Text as Prepared for Delivery
June 3, 1997

TREASURY UNDER SECRETARY FOR DOMESTIC FINANCE
JOHN D. HAWKE, JR.
HOUSE BANKING AND FINANCIAL SERVICES

Mr. Chairman and members of the Committee, I am pleased to appear
today with Secretary Rubin to discuss the Treasury Department's
draft proposal for financial modernization. The full text of
our proposal appears as part of the report that we are submitting
to the Congress pursuant to section 2709 of the Economic Growth
and Regulatory Paperwork Reduction Act of 1996.

As Secretary Rubin has testified, we believe that American consumers
will benefit significantly from legislation that brings increased
competition to the financial services industry. Our proposal
would achieve that result by eliminating barriers to affiliations
between banks and other financial services firms, and by broadening
the ability of banking organizations to offer financial products
and services. Specifically, we recommend that Congress repeal
sections 20 and 32 of the 1933 Glass-Steagall Act, which restrict
affiliations between commercial banks and securities firms, as
well as section 4 of the Bank Holding Company Act of 1956, which
narrowly limits the permissible activities of bank holding companies.

In place of these old restrictions, we propose that Congress adopt
a far less restrictive regime for companies that want to own banks.
We also propose that the authority of banks to engage in financial
activities through financial subsidiaries be broadened. These
changes would allow financial services companies that are, or
include, banks the freedom to choose between the holding company
affiliate and the bank subsidiary as the organizational format
for expanded financial activities. We have structured the proposal
to provide similar protections for the bank and the deposit insurance
funds irrespective of the choice of format. Let me expand briefly
on the rules we would apply.

The "Qualifying Bank Holding Company" ("QBHC")

The proposal sets out three main prerequisites for a company owning
a bank to engage in activities that are not permissible for a
national bank to engage in directly:

First, it must be engaged in activities that are "financial
in nature."

Second, all of its subsidiary banks must meet -- and remain
in compliance with -- the highest supervisory standard of capitalization,
the "well capitalized" standard, and they must be, and
stay, well managed.

Third, it must execute an undertaking that if any bank subsidiary
falls below the well capitalized level it will restore the bank
to that level or divest it under circumstances in which the divested
bank will be well capitalized immediately following the divestiture.

All bank holding companies would continue to be regulated and
supervised by the Federal Reserve Board, but they would be free
to diversify their financial activities within the limits described
in the legislation without further application requirements.

The Financial Subsidiary

Alternatively, national banks (and state banks to the extent permitted
by state law) may elect to conduct financial activities not permissible
for national banks themselves through their own financial subsidiaries.
Three conditions would apply if this format were chosen:

First, as in the QBHC setting, the parent bank would be required
to be and stay well capitalized and well managed.

Second, the amount of the bank's equity investment in the
subsidiary would be excluded from the bank's capital for purposes
of determining compliance with the well-capitalized standard.
Thus, if the subsidiary were to fail, the bank's regulatory capital
would be unaffected.

Third, after excluding the bank's equity investments in financial
subsidiaries, the limits on affiliate transactions in sections
23A and 23B of the Federal Reserve Act would be applicable to
dealings between the bank and the subsidiary. Thus loans and
other extensions of credit by the bank to the subsidiary would
have to be conducted at arm's length, could not exceed 10 percent
of the bank's capital, and would have to be fully collateralized.
(In addition, the bank's covered transactions with all affiliates,
including the subsidiary, could not exceed 20 percent of the bank's
capital.)

Subsidiaries of national banks would be permitted to engage in
the same financial activities as QBHCs, including insurance underwriting
and agency operations, and the full range of securities activities,
including merchant banking. (The permissible activities of subsidiaries
of state banks would depend on state law and review by the FDIC.)

The "Banking and Commerce" Issue

As Secretary Rubin has indicated, a major question that will face
the Congress in considering expanded activities for bank holding
companies is the extent to which -- if at all -- they should be
permitted to engage in nonfinancial activities. Congress has
a range of choices in this regard, and our proposal sets forth
two possible models that might be drawn upon as the Congress debates
this issue.

The first is a "basket" concept, similar to that suggested
in some pending bills. Under this approach, a company could only
be a QBHC if a predominant percentage of its domestic gross revenues
-- the exact number to be determined by Congress -- were derived
from financial institutions and other financial activities. If
this eligibility threshold were met, the remainder of the QBHC's
revenues could derive from nonfinancial activities. However,
in order to assure that the nonfinancial "basket" could
not be used to create very large combinations of banking and commercial
or industrial companies, we would prohibit a QBHC from acquiring
any nonfinancial company that had total assets in excess of $750
million -- a number that approximates the 1,000 largest nonfinancial
companies in the United States. We would also prohibit banks
from making loans to, or investing in, their commercial affiliates.

If such a "basket" approach were adopted, it would provide
a framework for merging the bank and thrift charters and bringing
unitary thrift holding companies, which presently have no limits
on their nonfinancial activities, under a common regulatory umbrella
with banking organizations. It would also provide a "two-way
street" that would make it possible for securities and insurance
companies and other diversified financial services firms that
may have some modest volume of nonfinancial revenue, to own an
insured bank.

On the other hand, Congress might choose not to permit any level
of nonfinancial activity for QBHCs. In this event, we believe
it would be difficult to merge the bank and thrift charters and
to eliminate the unitary thrift holding company, and, as a practical
matter, ownership of banks may be precluded for many securities,
insurance and diversified financial services firms. Accordingly,
if such a "financial-only" alternative were chosen,
we believe the thrift industry should remain unchanged from its
present configuration, with the unitary thrift holding company
format available for companies that could not qualify to own an
insured bank.

Neither model would permit subsidiaries of banks to engage in
commercial activities.

Federal Reserve Regulation of Holding Companies

The Federal Reserve would continue to approve the formation of,
and to supervise and regulate, all bank holding companies. The
Board could require holding companies to make reports of financial
information if the information is not reasonably available from
other sources.

Federal Reserve examinations of a bank holding company would be
limited, to the fullest extent possible, to holding company units
that could have a materially adverse effect on the safety and
soundness of a bank affiliate. The Board would have access to
examination reports prepared by federal or state regulatory agencies
and self-regulatory organizations.

The Federal Reserve would be permitted to set consolidated capital
requirements for a bank holding company if: the holding company
and the bank were large enough so as to raise concerns if problems
were to arise; the holding company's insured depository institutions
accounted for a predominant percentage of the holding company's
total assets; or an insured depository institution owned by the
holding company were less than well capitalized for more than
90 days, and the holding company engages in activities not permissible
for a national bank to engage in directly. Bank holding companies
not meeting any of these criteria would presumptively be excluded
from consolidated capital requirements, although the Board could
impose such requirements (for an individual holding company or
class of companies) if it determined that it was needed to avert
a material risk to the safety and soundness of a subsidiary bank
presented by unusual risk in the holding company's activities,
or particular characteristics of its financial structure. Where
the Federal Reserve did impose holding company capital requirements,
it would be required to develop rules for excluding from the holding
company's consolidated assets and capital both the assets and
capital of those company components subject to capital requirements
of other regulatory authorities, and the assets and capital of
other company components capitalized in line with norms for firms
engaged in the same line of business.

Wholesale Financial Institutions ("WFIs")

We also propose that Congress authorize wholesale financial institutions,
which would be chartered either as national banks or as state
banks that are members of the Federal Reserve System, but would
not be FDIC-insured and could not take deposits of less than $100,000.
WFIs would not be considered "banks" for purposes of
the Bank Holding Company Act; thus, like unitary thrift institutions
under current law, there would be no activity limits on their
owners. However, WFIs would be fully regulated by the OCC and
the Federal Reserve; they would have strong capital requirements,
enforceable through the usual prompt corrective action remedies;
the Federal Reserve would have broad authority to impose protective
conditions on WFIs in connection with their use of Federal Reserve
services; and WFIs would be subject to the Community Reinvestment
Act.

Functional Regulation of Financial Activities

While the Federal Reserve would continue to be the regulator of
all bank holding companies under our proposal, the usual regulators
of nonbanking financial activities would continue to regulate
those activities, whether conducted in a holding company affiliate,
a subsidiary of the bank or, with some exceptions, in the bank
itself.

All insurance activities, wherever they might be conducted in
a banking organization, would be subject to regulation by state
authorities under state insurance laws and regulation -- provided
that such laws and regulations were truly nondiscriminatory.
Where state law had the purpose or effect of discriminating against
financial institutions, or had a disproportionately restrictive
impact on financial institutions compared to other providers of
insurance in the same state, that law would not be applicable
to national banks. Similarly, we would retain the standard announced
by the Supreme Court in the Barnett case, so that a state
law that prevented a national bank from engaging in an insurance
activity authorized under federal law, or significantly interfered
with or impaired its ability to engage in such an activity, could
not be applied to national banks. State laws relating to the
rehabilitation, conservatorship, receivership, or liquidation
of insurance companies would be fully preserved.

Our proposal would narrow the Securities Exchange Act's exemption
of banks from broker and dealer registration to permit SEC regulation
of activities other than traditional banking activities. The
SEC's capital requirements generally may not be applied to a bank
that is well-capitalized. Traditional banking products would
not be subject to SEC broker-dealer regulation, and the primary
banking regulator and the SEC could jointly exempt new banking
products. We would update and clarify the Investment Company
Act's applicability to banking activities and limit the scope
of banks' exemption from the Investment Advisers Act. We would
generally have the SEC, rather than the banking agencies, handle
the registration of bank-issued securities and periodic reporting
by banks having securities registered under the Securities Exchange
Act of 1934.

Finally, the principle of national treatment will guide the application
of our proposal to foreign financial institutions operating in
the United States.

Conversion of Thrift Institutions

Title III of our proposal sets forth a comprehensive program for
eliminating the federal thrift charter, phasing out the separate
federal regulation of thrift institutions, and bringing unitary
thrift holding companies under the same regulatory structure as
bank holding companies. As I stated earlier, we believe a charter
and regulatory merger makes sense if Congress adopts a "basket"
approach that would accommodate some measure of nonfinancial activity
by bank holding companies.

Our model would accomplish the "merger" of the thrift
industry with the banking industry over a two-year period after
enactment. We believe that such a transition period is needed
both to allow thrifts to prepare to become regulated as banks,
and to permit an orderly merger of the Office of Thrift Supervision
(OTS) and the Office of the Comptroller of the Currency (OCC).

At the end of the two-year conversion period a number of things
would happen:

All federally chartered thrifts would be converted to national
banks, by operation of law. (They would also have the right to
elect an earlier conversion date, and they would retain the same
rights they have today to convert to any other available charter
prior to the end of the two-year period.)

All state-chartered thrifts would be treated as state-chartered
banks for all federal bank regulatory purposes.

Unitary thrift holding companies now in existence would be
given a grandfather exemption from the "basket" limitations,
conditioned on their not having a change of control or acquiring
an additional insured bank .

OTS and OCC would be merged, pursuant to plans developed by
the Secretary of the Treasury, effective two years after enactment.

Membership in the Federal Home Loan Bank System would become
voluntary for all institutions. (Mandatory membership would continue
for federally chartered thrifts until the end of the two-year
conversion period.)

BIF and SAIF would be merged. (The schedule established in
last year's legislation for phasing in sharing of the FICO bond
interest payments would not be changed.)

Several other important provisions are proposed in connection
with the conversion of the thrift industry to bank regulation:

Each banking agency would institute a program to accommodate
voluntary specialization in housing finance and the conversion
of thrift institutions to bank charters.

A mutual national bank charter would be made available to
accommodate thrifts presently operating in mutual form, and mutual
holding companies would be authorized.

With the merger of OTS and OCC, the size of the FDIC board
would be restored to three members, as it was for the 56 years
before the creation of OTS.

National Council on Financial Services

Our proposal would create a National Council on Financial Services,
consisting of the Secretary of the Treasury, the Chairman of the
Federal Reserve, the Chairs of the FDIC, SEC and CFTC, the Comptroller
of the Currency, the Director of OTS, and a final member, appointed
by the President with the advice and consent of the Senate, having
experience in state insurance regulation.

The Council would have authority to define additional types of
financial services companies' activities to be "financial"
for purposes of the QBHC test, and it could also prescribe additional
safeguards to promote safety and soundness. It would also serve
in a consultative role with respect to rulings by the OCC concerning
the applicability of state insurance law to national banks.

Consumer Protections

The proposal would require regulators to prescribe rules regarding
the retail sales of nondeposit investment products by banks and
their affiliates, in order to avoid customer confusion about the
nature and applicability of FDIC and SIPC insurance, and to protect
against conflicts of interest and other abuses. These rules would
address such matters as sales practices, qualifications of sales
personnel, incentive compensation and referrals. In addition,
they would require that disclosures be simple and readily understandable.
Customers could prevent sharing of confidential customer information
between banks and their nonbank affiliates. The National Council
on Financial Services would be required to review the effectiveness
of these regulations, and could prescribe more stringent rules
than those adopted by the agencies.

Effective Dates

Under the "basket" alternative, the expansion of bank
activities and affiliations would take effect two years after
the enactment of the legislation -- at the end of the period provided
for conversion of the thrift industry. If the second alternative
were adopted, with the thrift industry remaining as it is today,
we would propose that the expansion of powers and affiliations
for banking organizations take effect nine months after the date
of enactment.